Stocks fell sharply in early trading as fresh concerns about European sovereign debt pushed the euro to a 15-month low versus the dollar. But the tone improved in the afternoon as investors refocused on the relatively strong performance of the U.S. economy.

The rebound in bank stocks came amid speculation that the Obama administration could launch a new mortgage refinancing program, although the rumors were reportedly denied by the White House.

The market is caught in a "tug-of-war" between the improving outlook for the U.S. economy and worries about government debt and banking problems in Europe, said Paul Zemsky, chief of multi-asset strategies at ING Investment Management.

"There was nothing good out of Europe today, but we had some great news on the U.S. economy," he said.

Investors welcomed a better-than-expected report from payroll processor ADP and a decline in weekly claims for unemployment benefits. It was the latest in a string of encouraging reports on U.S. manufacturing, housing and the job market.

But after a brief respite over the holidays, worries about Europe have come back to the forefront in the first week of 2012.

"The realization that troubles in Europe are escalating has weighed heavily on markets today," said Camilla Sutton, chief currency strategist at Scotia Capital.

The euro fell 1.2% versus the dollar to $1.27, marking the lowest point for the common currency since September 2010. The sell-off in the euro came as investors were rattled by more turmoil in European sovereign debt markets

Spanish bond yields jumped after a government official said Wednesday that Spanish banks would need to set aside another €50 billion as part of a restructuring of the nation's banking sector.

The Labor Department said initial unemployment claims for the week ended Dec. 31 came in at 372,000 -- slightly lower than expectations of 375,000, according to a survey of analysts by Briefing.com -- and down from a revised 387,000 the prior week.

The jobs data come ahead of the Labor Department's monthly report on private-sector payrolls on Friday. Economists surveyed by CNNMoney expect businesses added 170,000 jobs in December, while the government cut 20,000 jobs, for a net gain of 150,000.

They're also forecasting the unemployment rate ticked up to 8.7% from 8.6% in November, mainly due to discouraged workers -- who had previously given up their job searches -- re-entering the labor force.

On Thursday, the Institute for Supply Management released the December installment of its services index, which tracks non-manufacturing orders, employment and inventories. The index edged up to 52.6 from 52 in the month prior.